Glut swamps storage industry
The fiscal woes of the storage business can best be described as the law of supply and demand meeting the domino effect.
The problems that started at the high end of the storage market have trickled down, and now companies like Western Digital (WDC) and Quantum (QNTM) are scrambling to offset losses from dropping prices and growing competition.
Overall, the storage market is going to add 27 million units in year-over-year shipments. But this year, roughly 4 million units are coming from suppliers that were hardly blips on the storage scene a year ago, said Alexa McCloughan, a storage analyst with International Data Corporation.
And that has unleashed a glut of products.
In the fourth quarter of 1997, Fujitsu is expected to ship 3.4 million units, compared with 1.9 million shipped during the same quarter a year ago. Maxtor is expected to ship 3 million units in the current quarter, compared with 1.3 million in the fourth calendar quarter of last year.
To maintain market share, companies that had carved out a niche for themselves in the storage industry began to cut prices. When the sequential price declines hit double digits, the dominos began to tumble.
The entry of more players into the storage market brought about a supply of products that quickly began to outweigh the growing demand. To clear out inventories and remain competitive, companies began cutting prices. But when the supply problems didn't clear up, storage companies reported charges in the fourth quarter.
Western Digital, for example, announced today that it will take larger-than-expected charges ranging from $85 million to $95 million because of the glut and higher-than-normal pricing pressures. It was the company's second warning for the December quarter.
Last month, Quantum said it would take a $40 million fourth-quarter charge, also attributing its charge to oversupply problems.
Around the same time, Seagate, long the leader in the storage industry, (SEG) announced that it too would miss Wall Street expectations for the current quarter, citing continued weakness in demand for its high-performance products, combined with greater-than-anticipated pricing pressure.
"The problem with price decline comes when declines are greater than cost reduction," McCloughan said. "Some of these companies are lowering prices to a point where they are breaking even or losing money, so they need to scale back."
That process has already begun. In essence, the supply overflow is just now passing over the levee walls built to stave off flooding earlier this year.
Things started to percolate in the supply channel in the high end of the market after the first calendar quarter ended, said McCloughan. Problems emerged when other top-tier players, like Quantum and Western Digital, also entered the high end--a market with not a lot of volume and one company, Seagate, already established as the dominant player.
The additional players in that limited field contributed to the pricing pressure at the high-end level. By the third quarter, however, the pressure began to bleed onto the low end as there was a dramatic jump in non-top-tier suppliers in the that area, McCloughan said.
Some analysts expected consolidation in the disk drive industry to lead to more rational pricing and less extreme earnings volatility. These analysts underestimated, however, the havoc that companies with relatively small market shares would wreak on pricing, according to a recent report by David Kerdell, an analyst with Oppenheimer & Company.
In 1997, Seagate held a 24 percent share of the market, compared with a 27 percent share last year; Quantum held a 21 percent share, compared with a 22 percent share last year; Western Digital held a 19 percent share, compared with 18-1/2 percent last year; and IBM held steady at 11 percent.
"Seagate has been hit hardest," McCloughan said. "It doesn't mean that they aren't growing--rather, they are not growing as fast as the market."
Making matters worse for these companies are persistent production problems.
WDC's margins during the quarter, for example, are being hurt by production problems with the company's 1.7GB product, Kerdell said. Those issues are within WDC's control to fix, he said, noting that there should be modest margin recovery during the second half of fiscal year 1998 even if pricing is unchanged.
Ashok Kumar, semiconductor analyst with Loewenbaum & Company, also sees an upside to the Western Digital charge. He said it could be the beginning of the end for good times in the PC market.
High forecasts combined with low prices are killing everyone, he said. The problems arise when growth isn't matching what Kumar called "spastic" expectations. WDC essentially got stuck with too much product that is losing value.
"Desktop price points are beginning to crater," Kumar said. "The only place of price stability is the enterprise, and God knows how long that will last."